Detox

Return to Article

Expensive Tastes Now Haunting Yahoo!

Peter Eavis

Call it Yahoo!'s (YHOO Quote - Cramer on YHOO - Stock Picks) virtual restructuring.

The Web giant reported second-quarter results Wednesday that showed traffic growth slowing, revenue slumping and profits evaporating. Yet Yahoo!'s costs continue to creep higher.

Clearly, Yahoo! is ignoring its expenses in the belief that revenue will soon soar, reinvigorating profit margins. Part of the bet is that Terry Semel, Yahoo!'s new CEO, will succeed in generating new revenue sources, particularly by making users pay for services. But before long, investors are going to clamor for a deep Old Economy restructuring that slashes overhead. In other words, Semel has to find a way of keeping costs down at the same time as diversifying revenue. The stock may be soaring in after-hours trading Wednesday because the company beat analysts' revenue and earnings forecasts, but the market won't long support a 2002 price-to-earnings ratio of 120 -- not to mention 2001's 450 ratio.

Story Time

A Yahoo! executive repeatedly boasted about disciplined expense control on the conference call Wednesday evening. But the numbers tell a different story. Second-quarter revenue of $182 million was 33% below the year-ago period. Yet total pro forma costs rose 6%, to $191 million. Cost of revenues jumped 7% from a year ago, while overhead and product costs each rocketed at least 20%.

Of course, it makes little sense to slash costs in line with the revenue decline. But cutbacks will be necessary; the second-quarter per-share profit of a penny masks the fact that core operations are bleeding red ink. The company made it into the black only by booking $25 million in other income, mainly via returns on cash and cash equivalents. Yahoo's operations showed a pretax loss of $9 million, or 2 cents a share.

A classic excuse at Yahoo! is that it can make money from its heavy traffic and huge user base. The problem is that growth in both categories slowed markedly in the second quarter. In June, unique users rose 28% from a year ago, to 200 million. That looks strong, but unique users were growing at a 32% clip in the first quarter and 50% in the fourth quarter.

What Price the Web?

Yahoo! appears to be overpaying for these extra users. Dividing the quarterly sales-and-marketing expense by the incremental addition in unique users or active registered users gives a rough idea of how much Yahoo! is forking out. In the second quarter, Yahoo! "paid" $12.44 per new unique user, compared with $8.87 in the first quarter.

Meanwhile, average daily page views rose 9% from first-quarter levels, to 1.2 billion. First-quarter sequential growth was a more impressive 22%.

Finally, Yahoo!'s e-commerce push appears to be faltering. The company enabled $1.3 billion in commerce transactions in the second quarter, down from $1.4 billion in the first quarter.

Time for Terry to swing the ax.